BofA and Stating the Obvious About Bank Profits

Bank of America’s unexpectedly large loss differs from the unexpectedly large gain at JPMorgan (JPM) only in tertiary ways. The expected pattern was better fixed-income trading results combined with deterioratng credit books. With about 20% of the US workforce un- or underemployed, it is hard to imagine any other result. A higher default rate for consumer loans is to be expected. But what about the surge in trading profits?

Subprime AAA Securiites (So-Called), 2007 Vintage

The price of so-called toxic waste has surged, despite the fact that the cash flows from the toxic waste are just as dicey as the consumer loan book. Shown above are securitized AAA securities backed by 2007 vintage (that is, bottom of the barrel) subprime home-equity loans Why is their price so high? Because the Federal Reserve continues to buy huge amounts of mortgage backed securities, and because the Treasury and Fed are providing ultra-cheap, non-recourse financing for banks (through Public-Private Investment Partnerships) to buy these securities.

At the beginning of the year, I stressed over and over again that with a minimum of regulatory forbearance, the big banks would NOT go bankrupt: They had sufficient cash flows left to wring out of the toxic waste to keep one nostril out of the water. Now we have the opposite problem: The Federal Reserve and Treasury have helped the banks create a mini-bubble in what used to be called toxic waste (remember, that was the stuff that was supposed to be taken off the banks’ books so that they could resume lending to business?).

Of course the banks show an increase in fixed income trading profits! WIth cheap financing from the government, they made markets for very yieldy securities bid-only. Prices went through the ceiling. You only had to stand still and hold a suitcase-full of these securities in order to show trading profits during the third quarter.

Of course, those profits are a one-time, unrepeatable exercise; they are likely to lead to losses in the future (except to the extent that the banks can sucker their customers back into PPIP-backed toxic waste fund); and loan book losses will continue to pile up.

I bought the banks too early, at the beginning of the year, and sold too soon, in early September. Nonetheless the trade worked out. I’m not playing any more.

Comments

[CautiousInv...:]

"Shown above are securitized AAA securities backed by 2007 vintage (that is, bottom of the barrel) subprime home-equity loans Why is their price so high? Because the Federal Reserve continues to buy huge amounts of mortgage backed securities, and because the Treasury and Fed are providing ultra-cheap, non-recourse financing for banks (through Public-Private Investment Partnerships) to buy these securities."
______________________...

We have socialized banking system losses through Fed purchases and there is now discussion of extending this program of purchases of MBS which will invariably leave the Fed with losses. ( no wonder they oppose an audit ) It's incredible the lengths we have gone to satisfy the demands of the banking oligarchy: TARP, accounting changes, payment of interest on reserves, a fraudulent bank examination disguised as a stress test, delays in financial reform, preservation of the too-big-to fail doctrine and allowing banks to recapitalize by renting Treasury's balance sheet under FDIC guarantees.

Oct 16 10:52 AM

[JasonC:]

The Fed isn't going to lose anything buying agencies MBS securities. It is going to make somewhat more profit than it makes in treasuries.

Oct 16 04:28 PM

[JasonC:]

The real story in the B of A report is they remain cash flow positive as they have throughout. They added another $2.1 billion to their loss reserves, matching the loss to the common pretty much. There was also the $1.8 billion item from writing *up* the value of debt issued by Merrill because its credit improved.

Trust me, they won't go bankrupt through an improving credit rating.

They tick over around break even until the credit loss rate turns, then they pop upward. The net cost of the entire crisis will be a dilution a bit under half, from being forced to issue lots of stock at lousy prices to maintain capital at the bottom. In return they will have Merrill and be a $2.5 trillion bank in the next up cycle.

Everyone reacting to it as some disaster is smoking something, it was a non-event report...

Oct 16 04:32 PM

[Eb07:]

Agree completely with JasonC. B of A looks like a stable play, and the crisis creates an opportunity to get rid of their excesses, which may lead to greater profitability when things turn around.

This bank has been around for ages, why should this crisis be any different? Here's a Flickr slideshow featuring vintage commercials for some perspective: www.flickr.com/photos/.../

Oct 16 05:36 PM

[fotokemist:]

The Fed has assured us BOA will not be allowed to "fail". My belief is that position is intended to reassure counter-parties. They have not assured us of an increasing stock valuation or even that the bank will not be nationalized. As I recall, Mr. Obama made a very clear statement about the consequences of future bailouts in his wall street speech a few weeks ago.

The stock valuation is a separate matter. I don't know how one can justify any price for the stock given the unknown real value of their assets (in other words, how long will "profits" be consummed as they adjust reserves to realize the losses being ignored by current accounting practices.) Then one reads reports (rumors?) of vast off-balance sheet loses that will have to be realized someday, perhaps as early as next year. What happens to BOA stock price if rising oil prices (in $) force the Fed to support the $? What if either increasing energy costs or rising interest rates (to support the $ and avoid the rising energy costs) leads to a W recovery?

I have a hard time reconciling shipping being down 17% YoY, consummer credit contracting at historic levels, retail sales being down 5 - 10% YoY in reporting retailers, and consummer consumption being an increasing fraction of our GDP with the idea that we are seeing a recovery.

Oct 17 06:01 PM

[multi007:]

Merill Lynch is saving BAC right now. Looks like Ken Lewis will be a saint by the time this all blows over. Even with the shareholder lawsuits, shareholders should know that without Ken Lewis's actions, their shares would have been zero. Like Bearsterns etc..

Oct 18 03:09 PM